Jason Pope

Conduct Policy Division

Financial Services Authority

25 The North Colonnade

CanaryWharf

London

E14 5HS

21 April 2011

Dear Jason,

AFM Response toDP11/1, Product Intervention

  1. I am writing in response to this consultation paper, on behalf of the Association of Financial Mutuals. The objectives we seek from our response are to:
  • Comment on the discussion points raised in the paper; and
  • Consider what impact greater product intervention might have on the market for financial services.
  1. The Association of Financial Mutuals (AFM) was established on 1 January 2010, as a result of a merger between the Association of Mutual Insurers and the Association of Friendly Societies. Financial Mutuals are member-owned organisations, and the nature of their ownership, and the consequently lower prices, higher returns or better service that typically result, make mutuals accessible and attractive to consumers.
  1. AFM currently has 57 members and represents mutual insurers and friendly societies in the UK. Between them, these organisations manage the savings, protection and healthcare needs of 20 million people, and have total funds under management of over £80 billion.
  1. The basis by which FSA has approached this paper is that consumer protection warrants earlier and greater intervention in the product life cycle. We accept this: historically UK regulation has focused on the sales regime and given little regard to whether it was appropriate for products with features that might cause consumer detriment to enter the retail market.
  1. There is therefore a case for some degree of product regulation, to ensure that products that enter the retail market have been properly calibrated and tested against relevant risks, allowing distributors to sell, and consumers to buy, with confidence. Any intervention must reflect the extent to which most firms have successfully implemented TCF programmes and a customer-orientated culture, and that FSA should avoid duplicating or contradicting the effect product development processes already in place.
  1. Any intervention should not seek to deliver a zero failure regime, as it is inevitable that some market failure is likely to occur even in the best regulated markets, because not all possible problems can be identified or tested. Indeed, product intervention brings with it a risk to regulators, depending on the nature of that intervention, that it potentially provides safe harbour for a product: should there be a subsequent failure, the regulator would have to accept part of the responsibility.
  1. From a firm’s perspective our greatest concern for the proposals is that as FSA only has jurisdiction over product development in the UK, then unilateral action will enable overseas providers to gain a competitive advantage compared to companies based in the UK (either through shorter time to market or by changes required to features or descriptions as a result of intervention). This may well have a seriously detrimental impact on the UK financial services industry and therefore is not consistent with FSA’s statutory objectives or the relevant principles of good regulation.
  1. Our answers to specific questions are attached. Wewould be pleased to discuss further any of the issues raised by our response.

Yours sincerely,

Martin Shaw

Chief Executive

Association of Financial Mutuals

Answers to specific questions

Q1: What issues should we consider in relation to how our product intervention approach affects equality and diversity?

Q2: How could we use our focus on products to promote equality and diversity?

Equality has many dimensions, but those of most relevance here are equality of access; a common market for products; and fairness. Diversity implies that products are available to meet identified needs, where the range of possible outcomes is understood, and the relevant risks identified.
A proportionate approach should recognise that small firms are often more flexible and innovative; that intervention may slow down development, or complicate the development process, thereby leading to fewer products and providers available to satisfy niche markets.
With regard to retrospection/ hindsight, no-one has perfect knowledge and it is too easy to look at past issues with the advantage of today’s knowledge. For example,in the past FSA determined that banks should be subject to light-touch regulation, as the complex nature of their businesses and the risks involved were not properly understood. Similarly FSA approved the development of Child Trust Funds in friendly societies, but now criticises such firms as having too narrow a business plan.
FSA has not previously shown itself to have the skills, knowledge to understand products that might fail; or the processes to act on possible problem products. This needs to be addressed as part of a more interventionist approach. FSA also gives the impression often of approaching issues with an engrained analytical mindset, something which might not enable it to properly evaluate or appreciate the wider customer proposition or benefits associated with a proposed new product development.
In addition, FSA has a statutory obligation to support competition but risks putting some firms at competitive disadvantage: for example by intervening in some areas but not within close substitutes, or for UK based firms compared to firms selling from elsewhere in Europe.
Mutuals are widely recognised as working more effectively in the interests of their customers, and of upholding the principle of Treating Customers Fairly (this was helpfully acknowledged by Which? at a recent FSA roundtable). In respect of mutually-owned organisations, as part of an intrusive approach FSA must, when taking account of product development, respect the rights of all policyholders, and of members in a mutual. In a recent consultation on with profits, FSA ventured a view that “with profits policyholders have an interest in every part of the with-profits fund”- this is not consistent with the history of with-profits, but has the implication that it could stop mutuals developing new products where capital is sourced from the with-profits fund. The consequences of intervention need therefore to be clearly understood, and married to broader regulation.
Q3: Do you have any comments on our market failure analysis?
Q4: What do you think are the criteria by which we should judge when to intervene further?
Q5: Are there any other relevant indicators that would help us identify potential problems?
Chapter 3 provides an extensive set of possible market failures. By the nature of the paper there is little balance provided- but it should be reiterated that the vast majority of consumers have good experiences with the financial services industry. So in terms of balance, in general people are better to save imperfectly than not at all; and most firms actively pursue an effective treating customers fairly agenda now.
One person’s product failure is another’s opportunity: risk itself depends on a range of functions, and a person’s attitude to risk will change over time- so there is a real danger of too simplistic an approach. Many AFM members work closely with poorer families as their core market- in these segments of society, premiums are typical low, levels of cancellation are high, and profit is only likely in the long term. But like any other market, these markets are only attractive if the provider and distributor can themselves see a satisfactory risk-return ratio. Intervention increases one at the expense of the other and reduces the likelihood that some markets, such as those in most need, are properly served.
Q6: Do you have any comments on the supervisory approach we have adopted, or suggestions to help develop it?
Chapter 4 highlights the wide range of supervisory tools and processes in place, and it cannot be argued that these support a more interventionist approach.
The Chapter though does not explore whether the supervisors themselves have the relevant experience of skill set to use the tools or to exercise appropriate discretion. We are concerned for example that especially amongst mid-sized firms, supervisory turnover is too high (there are numerous examples of four lead supervisors over a two-year period).
Given this, supervisors often only have a superficial knowledge of the firms they supervise and will not have the length of relationship that allows them to exercise discretion where the firm is well-run, or to identify an emerging trend that might cause issues in future.
Q7: Should we give further consideration to new rules to prescribe conduct by firms when designing and managing products?
Q8: If so, what should be covered?
Q9: What would the impact be on the market?
We find it difficult at this stage to say: the discussion paper neither proves the case for new rules, nor demonstrates that the proposed approaches are consistent with the current rulebooks, FSA’ statutory objectives, the principles of good regulation, or the principles for business. We consider further and fuller analysis should be provided for some of the proposed interventions. AFM and its members are happy to assist in this work.
Separately the Treasury has recently consulted on proposals for simple products, and the possible extension of RU64 across relevant product categories. FSA has considered such an extension in the past and a similar review would be helpful here.
Q10: What would the implications be if we consider similar interventions for services as those discussed in this paper for products?
If the purpose of product intervention is to ensure that products that enter the retail market are always appropriate, then where specific services act as substitutes for products they should be regulated in a consistent manner. If regulators do not approach this in a comparable way they will be placing services at an unfair advantage, and FSA will fail against its own principle of good regulation relating to competition.
Q11: Do you have any comments on any of the possible additional interventions?
Q12: Which activities could we define as non-mainstream advice for the purposes of developing additional qualifications?
Q13: Are there any other interventions we should consider?
Q14: What would the impact of these specific interventions be on the market?
There are enormous risks in some of these approaches and it is not clear all of the proposed forms of intervention are within FSA’s current powers: it would be helpful in any future papers for FSA to cross-reference each proposed activity to the underlying regulatory objective/ FSMA power.
Regulators and compliance officers rarely make good product developers or marketeers, so the likely outcome is that such interventions will restrict innovation in the market and commoditise many products. Speed to market is often a critical aspect of achieving a successful market share: a firm might typically envisage a six-month development time at present; this is likely to increase where there is regulatory intervention, and a delay of one or two months may be catastrophic, especially where a market is time limited (eg by the financial year).
Another concern of providers is that for FSA to add value to the product development process, it may become difficult to maintain confidentiality where feedback is provided to an individual firm (and for it to operate effectively it must provide such feedback, otherwise it will just be an added layer of time consuming bureaucracy).
Restricting innovation may not always be bad for consumers, and will certainly avoid the development of clearly unsuitable products. However our experience is that genuine innovation for good often emerges from small, niche providers, eg Holloway income protection that gives cover from the first day of illness, rather than after 13 weeks. Such small niche players are at greater risk of invalid intervention from regulators who fail to grasp the nature of the market or the virtue of the product.
Indeed, in our view, intervention puts a big onus on FSA to show it understands the needs of consumers rather better than it has in past. We would expect therefore that the regulator would need to conduct more extensive consumer research than at present to understand consumer behaviours, and to analyse the impact of any interventions, before and after the event. This will also help ensure that any intervention is proportionate to the potential for consumer detriment, the nature of the provider or distributor, and the form of the product.
The discussion paper proposes a hierarchy of intervention, but it is not clear how and why this has been arrived at. For example the paper suggests that banning non-advised sales is seen as non-intrusive. We do not agree: recent research from ABI suggests 50% of consumers will not pay for advice, and 30% will pay no more than £300; so it is quite possible that a significant proportion of consumers will need to be served via non-advised routes post-RDR. In competition terms therefore, banning non-advised sales is on a par with banning products.
As well as the options provided in the paper, there is a range of alternatives which we consider bear further scrutiny:
  • Whistleblowing to ensure problems are acted on more quickly
  • Better liaison between FSA and other regulators (FOS; OFT etc)
  • More effective two-way liaison between supervisors and firms
  • Working with ABI to update their Good Practice Guide on Product Development
  • Using the Comparative Tables, now managed by the Money Advice Service, to provide more effective benchmarking- for example by extending categories compared, requiring firms to submit data, and better promoting the tables
  • Stronger action against management of firms where problems occur
  • Financial promotion bans on products considered unsuitable for the mass market
  • Better and simpler signalling of risk (eg “this product should only be purchased by experienced investors and with financial advice”)
  • Consumer education is a valid albeit long-term option; regrettable that the transition of CFEB to the Money Advice Service has resulted in funding for education (eg to pfeg) being significantly cut.

AFM response to DP11/01, Product InterventionPage 1